MF Global

Pairs Trading

Market Neutral (Pairs Trading) Explained

To illustrate a Pairs Trade in practice, lets examine what would have happened in if you had been bullish of Suncorp Metway (SUN) and bearish of St. George Bank (SGB). The trade was initiated at a ratio of 1.87 and taken off at a ratio of 1.75 (20.52/11.75 = 1.75).

As we are selling the higher priced share (SGB) and buying the lower priced share (SUN), this is referred to as “selling the ratio” i.e. to profit from this particular example we want to close out the trade when the ratio is lower than the opening value of 1.87.

Example Pairs Trade

		LONG - SUN		SHORT - SGB	RATIO
Open Position 28/06/03
Prices		$11.53		$21.55	1.87
Consideration		$20,004.55		$19,998.40
Margin (security deposit)	10%	$2,000.46	10%	$1,999.84
Commission	0.25%	$50.01	0.25%	$50.00
Initial Outlay		$2,050.47		$2,049.84

Close Position 17/09/03
Quantity		1,735		928
Price		$11.75		$20.52	1.75
Consideration		$20,386.25		$19,042.56
Commission	0.25%	$50.97	0.25%	$47.61
Financing (base rate +/- 3%)*		DR$344.05		CR $77.67

Profit/Loss		-$63.33		$935.90

Total Profit on Trade				$872.57

*Assumes base rate of 4.75% for duration of trade

In order to track the profitability of this Pairs Trade, one could either manually calculate the ratio by simply dividing the higher priced share by the lower priced share, or more easily by following it graphically.


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